Plans Must Carefully Field ERISA Claims and Settlements

There are few, if any, regulations providing direct guidance on this matter.

When a 401(k) retirement plan is awarded damages or receives a settlement from a lawsuit, it is incumbent on the retirement plan adviser to help the plan administrator figure out how to award the funds to participants.

Generally, the funds are first placed into a holding account, explains Daniel Johnson, head of the employee benefits and compensation practice at Moore & Van Allen in Charlotte, North Carolina.

Then, the first distribution of the settlement goes to pay attorney fees, says Mike Kasecamp, retirement plan consultant at CBIZ Retirement Plan Services in Columbia, Maryland. Their fees are typically 25% to 30% of the settlement, Kasecamp says. “It is unfortunate that with many of these settlements, the participants receive such small funds, while the attorneys can get millions,” he says. (See “Leveraging ERISA Attorneys.”)

Next, the administrator must figure out how to distribute the funds to participants, relying on the detailed files of their recordkeepers to determine how to allocate the funds on a pro rata basis, Johnson says. Sponsors typically divide the settlement by each participant’s balance at the time of receipt to figure out a percentage to pay them, Kasecamp says.

If the settlement was determined in a relatively short period of time, it could be easy for the administrator to allocate the funds, Johnson says. However, in most cases, lawsuits carry on for several years or longer. In that time some participants many have left a plan, making it challenging for the administrator to locate them and potentially causing delayed payments, Johnson says.

“Plans don’t stay static,” Johnson says. “People move their money around, and some people may have paid out or have left the company.”

NEXT: Be meticulous 

It is important for advisers to be very meticulous about how they allocate the settlement moneys.

“Unfortunately, current regulations do not give specific instructions, and the process for allocation to participants may not be the same for every single plan receiving a settlement,” says Rick Skelly, client executive at Barney & Barney’s retirement services division, based in San Diego. “When the plan receives the actual settlement check, it doesn’t come with specific allocation instructions to the participants. The plan sponsor must determine the allocation themselves.”

In some cases the settlement agreements includes a formula for allocating the funds to participants, says Marcia Wagner, principle with Wagner Law Group in Boston.

As to how participants receive the funds, for those who are currently still in the plan, it is placed into their account, Johnson says. For those who have left the plan, “it will be a trailing distribution,” he says.

In some cases, sponsors may decide to allocate the funds only to those who are currently in the plan, Skelly says. However, if it is not “administratively feasible” to allocate the funds to the participants, “the payment may, to the extent permitted by the retirement plan, be used to pay reasonable administrative expenses associated with maintaining the retirement plan,” he says. “The money would be deposited into the forfeiture account in this instance.”

In addition, if the lawsuit has dragged on for a long period of time and many of the participants have left the plan and are unreachable, this could also prompt the sponsor to allocate a settlement to the plan’s administrative expenses, rather than to participants, Skelly says.

NEXT: How settlement payments appear on statements

When the settlement payments are issued to participants, because they typically are so small, they are simply added to the participant’s earnings on their account statement, Johnson says. “Most of the time, these settlements end up being pennies to a few dollars” per participant, Kasecamp agrees.

However, “If it is a big number and has gotten a lot of press, the sponsor will probably ask the recordkeeper to represent the figure as a line item,” Johnson says

While most retirement plan accounts are daily valued, and issue statements to participants each quarter, a few plans balance their accounts only annually, Kasecamp says. “These are balance-forward accounts, and in these cases, these plans would hold the funds until the end of the year,” he says.

If the settlement is awarded to a defined benefit plan, “damages and settlement proceeds would be comingled with the plan’s other assets, and no participant would have a claim against any specific portion of the assets,” Wagner says. “Plan benefits under these plans are generally determined under a formula based on a participant’s compensation and length of service.”

As to when taxes are paid on settlements, because 401(k) retirement plans are tax-exempt, the settlements are generally not taxed, Wagner says. Participants pay taxes when the funds are distributed, she says.

NEXT: Other best practices

As to other considerations advisers and sponsors must keep in mind when handling settlements, Johnson says that “a lot of times, these settlements involve the stock of the sponsoring employer. As a party in interest, it is a prohibitive transaction for the employer to receive such settlement money. Therefore, the employer has to go through a prohibitive transaction class exemption to make sure the settlement is exempt.”

And just like any other fiduciary action, it is important that the sponsor “make sure that the funds are allocated to the correct participants and document how they came up with the figure,” Kasecamp says. “The best way to handle any fiduciary best practice is to ensure it is a prudent process and that is documented.”

In addition, it is important for the sponsor to determine whether accepting a settlement is a better option than pursuing a lawsuit, Wagner says. “Prior to opting for a settlement, ERISA requires a plan fiduciary to conduct a prudent evaluation of whether the settlement is reasonable and the settlement proceeds are at least as valuable as the likely recovery from pursuing all aspects of the claim, including both securities fraud and ERISA causes of action,” she says. “The plan fiduciary should consider whether the receipt of the settlement proceeds outweighs the possibility of receiving a larger recovery by not participating in the settlement and pursuing the ERISA claims.”